WASHINGTON The head of a U.S. financial bailout watchdog panel said bankruptcy judges must be allowed to reduce home mortgage debt or the Obama administration's housing rescue efforts could fail in the areas where they are most needed.
Elizabeth Warren, who chairs the Congressional Oversight Panel for the Troubled Asset Relief Program, told the Reuters Global Financial Regulation Summit in Washington on Monday that her biggest concern about the housing plan was the "failure to deal with underwater mortgages".
The Obama administration's refinancing aid so far will not help much in hard-hit housing markets where home prices have fallen 30 to 50 percent below their mortgage principal, she said. So-called "cramdown" changes to bankruptcy laws or other legal devices were needed to cut mortgage debt to underlying home values.
"It would be the one way to deal with principal that exceeds the value of the loan," she said. "Without that, we risk a foreclosure mitigation plan that is helpful in the areas of modest need, but not helpful where the problems are acute."
Warren, a Harvard Law School professor, said the inability to write down home mortgage debt was an exception to most bankruptcy law, which allows judges to reduce other forms of debt.
"If this were business property, a chapter 11, or a corporate chapter 7 proceeding, there would be no restriction to write down the secured debt to the value of the collateral," she said. "The law recognizes everywhere the importance, in a financial crisis, of recognizing losses, taking the hit and moving on," she said.
She said she could only attribute the existence of the exception to the political clout of the mortgage banking industry. If the cramdown proposals fail in Congress, "It means that the banks are still calling the shots."
Reducing mortgage principal, via bankruptcy court or otherwise, would reach a more "economically rational" solution to the problem of underwater mortgages by minimizing investor losses and maximizing the repayment ability on the loan.